cvernon, Author at Marquette Associates

Second Quarter Review of Asset Allocation: Risks and Opportunities

The second quarter of 2020 proved to be as eventful as the first, with slow economic results being largely ignored as markets rallied. GDP growth for the quarter is expected to come in at -35.5% YoY, though 3Q GDP projections indicate a significant rebound is expected as the country begins to reopen to “the new normal.” In addition, the unemployment rate came in at 11.1%, down from the April peak above 14%. Below are some highlights from the quarter:

Countries around the globe began reopening businesses amid fears of a second wave of COVID-19 infections.
Daily infections reached a new high in the United States at more than 50,000 per day, causing some states to roll back their reopening plans.
Weekly initial claims for unemployment insurance have continued to trend downwards.
Additional fiscal and monetary stimulus are expected in the second half of the year, bolstering markets.

COVID-19 has proven to be a potentially long-lasting concern as it remains to be seen whether we are in for a V-shaped or U-shaped recovery. Economic data is improving slowly, though markets have seemed to shrug off some of the negative news as the S&P 500 moved into positive territory over the one-year period. Though it may have fallen into the background due to COVID-19, 2020 is a presidential election year. Uncertainty surrounding the election will undoubtedly have an impact on forward-looking expectations. In this newsletter, we analyze what all of this means for each asset class.

Read > Second Quarter Review of Asset Allocation: Risks and Opportunities

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Coastal COVID: Diverging State Responses

Nearly a month into summer, the tragedy of COVID-19 rages on globally and in the U.S. As of July 13th, America’s death toll sat at over 135,000 with total cases approaching 3.4 million. The good news is that a number of virus hot spots have largely been tamed, most notably New York. To maintain this progress, Governor Cuomo implemented a mandatory quarantine period for travelers arriving from a number of other states. Elected officials in other once hard-hit locations, including Chicago Mayor Lori Lightfoot, have followed suit. Yet, despite the progress in some parts of the country, others are going in the opposite direction.

Two of the most populous states, California and Florida, have made headlines recently for their surging cases but differing responses. As of July 13th, California had 336,508 positive COVID-19 cases. Accelerating this grim total was a notable increase in the infection rate during June, which has continued into July. In response, Governor Newsom announced renewed restrictions this past Monday, and although not as wide-ranging as the initial spring lockdown, they are effectively a statewide ban on indoor activity with 80% of California residents affected. Also newsworthy was the announcement by both the Los Angeles and San Diego school districts that the school year will begin fully online.

Facing just as significant a problem, Florida’s case count sat at 291,629 on July 13th. Despite the rising cases and recently deemed “epicenter”¹ of Miami, Florida’s Commissioner of the Department of Education issued an order on July 7th that all of the state’s schools open for full-time in-person learning next month. After another week of surging cases, support for this directive was offered by Senator Marco Rubio on Monday, noting that “additional measures” be taken in hot spot locations. And, in the Sunshine State, it’s not just schools that are heading towards a return to normalcy. Disney World opened its doors for the first time since March last weekend.

The divergence in responses between these two coastal states highlights the differences in opinion witnessed since the start of the pandemic and helps explain the inconsistent success rates across states in controlling the outbreak. Though progress has been notable in the U.S., this most recent pattern suggests that a more uniform approach to battling the pandemic could help reduce the spread of COVID-19. The coming months will be telling for financial markets: the longer that the pandemic surges, the more volatility and headwinds will dominate the headlines and investor returns. On the other hand, if a more uniform and consistent approach can be embraced, the curve is sure to be shortened and a return to normalcy should be expected sooner rather than later.

Print PDF > Coastal COVID: Diverging State Responses

¹Dr. Lillian Abbo, University of Miami, via NPR

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Best Historical Performing Asset Class Is on Sale!

It is critical for institutional investors to understand the importance of both relative and absolute value when considering investment allocations. From a relative value perspective, private equity — which has been one of the most desired and consistently best performing asset classes over the last 20 years — is now on sale.

Following global investment volatility and panic from the COVID-19 crisis in March, the combination of government intervention along with public equity enthusiasm has driven public valuation multiples to near-record levels over the last three months with the Russell 3000 trading at 15x EV/EBITDA (S&P 500 at 23x EV/EBITDA), making the relative value trade even more compelling for private equity investments. Meanwhile, private equity multiples have been more stable, with May transactions occurring at 10x for middle market buyouts and 7.5x for small buyouts less than $100 million in enterprise value, providing investors a 35% or 50% relative discount respectively as compared to the Russell 3000. The current valuation spread provides the widest spread these markets have offered.

Private equity managers have mostly shown investment discipline, thinking longer-term and focused on absolute returns over a multi-year basis, which has resulted in a tighter range of valuations paid as compared to rising public equity multiples over the last decade. However, given the current market dynamics with the valuation spread growing, it is likely private market investors will benefit from the relative outperformance of private equity capital deployed in 2020.

This may be an opportune time for institutional investors to consider stepping back from elevated public market valuations and find ways to allocate more capital and raise their targeted allocations to private equity in order to maximize the absolute returns of their portfolios. We have seen clients increasing their annual deployment and focusing on more opportunistic strategies, including co-investment funds and secondary funds which have shorter investment periods thus allowing more capital to be deployed in 2020 and 2021.

Furthermore, private equity managers should increasingly be thinking about the relative value of the capital that has been committed to them. The last few years have provided for record-breaking fundraising for the private equity industry. This committed capital is currently sitting in dry powder and in most cases remains uncalled from investors sitting in public equity markets. Due to the current valuation spread, the relative value these private equity managers provide by finding opportunities present in the private market is great. Most importantly, more capital being put to work in private markets can expand the number of private equity-owned businesses and does not have to drive up the valuations paid, unlike in public markets where there are a fixed number of opportunities and where more capital being deployed in public equities pushes valuations higher.

Print PDF > Best Historical Performing Asset Class Is on Sale!

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Financial Factors in Selecting Plan Investments Proposed Rule

On June 23rd, 2020, the U.S. Department of Labor released a proposal to amend certain fiduciary regulation around the consideration of economically targeted investments, or those that incorporate environmental, social, and governance factors.

The purpose of this legislative update is to provide some background on ESG integration and the subsequent DOL guidance on these issues as well as a summary of the Proposed Rule and its impact on ERISA plans.

Read > Financial Factors in Selecting Plan Investments Legislative Update

For additional Marquette coverage on sustainable investing, reference our recent newsletter, Sustainable Investing in a Post-COVID World, and white paper, The Future of Investing: Sustainability and ESG Integration.

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Russell Rebalance: What Happened?

Summer has arrived and with it comes the annual “Russell Rebalance,” or as FTSE Russell — the index administrator — officially calls it, the Russell Reconstitution. The last Friday in June brings a unique set of challenges for investors managing to one of Russell’s many indices. More than half of U.S. equity investment managers benchmark to a FTSE Russell Index and the Russell rebalance affects an estimated $9 trillion across these products.¹ The entire family of Russell U.S. indices is recast to reflect changes in the U.S. equity markets over the preceding year. Essentially, the rebalance resets market cap weightings and style designations, which ultimately drive shifts in the underlying sector distributions. This creates one of the highest trade-volume days of the year.

The market’s appreciation over the longest bull market in history pushed the market cap breakpoint between the asset classes to a peak in 2018 of $3.7 billion. As a result, the market cap threshold for constituents to be placed into either the large- and mid-cap focused Russell 1000 Index or the small-cap focused Russell 2000 Index has grown 150% since the Great Financial Crisis.

This past Friday, June 26th, marked the official reconstitution day. Notable movements in this year’s rebalance revolved around a few key sectors: Financials, Health Care, Industrials, and Information Technology. The Russell 1000 saw little movement in sector allocation, while the respective style indices, the Russell 1000 Growth and Value benchmarks, experienced the brunt of change. Technology now comprises a record 43% of the Russell 1000 Growth Index, a 2.3% rise, while the Industrials allocation fell to 4.6%, from 7.3%. The Russell 1000 Value Index was the recipient of those Industrials companies, rising from 9.6% to 12.4%.

From a market cap perspective, many banks within the Russell 1000 Financials sector moved to the small-cap index as investors sold economically sensitive stocks in the first quarter of the year. The Russell 2000 Index saw a 1.6% increase to the sector, bringing the total weight in Financials to 16.2%. As expected, many of these banks qualified for the Russell 2000 Value Index, which now has a nearly 29% weight to the sector. Likely the largest hurdle for active managers navigating the rebalance is the increased allocation to Biotechnology, an industry within the Health Care sector. These securities, many of which do not make money and have no established products, go against the investment philosophies of many fundamentally driven active managers. The Russell 2000 Growth Index now has a more than an 18% allocation to the industry. As managers settle into their new benchmarks, it will be pertinent to discuss these sectoral and capitalization changes in the context of future performance expectations.

Print PDF > Russell Rebalance: What Happened?

¹ FTSE Russell

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Private Equity in Times of Crisis

While there is still much uncertainty around the long-term economic ramifications of COVID-19, financial markets have been undergoing frequent massive swings as both investment managers and allocators evaluate the situation and what it might mean for their current and future investments. Given the illiquid and slow-moving nature of private equity investments, an outstanding question is: What will this mean for private market investors?

One principle which people took serious note of in the last crisis was something called the “denominator effect.” A decline in the value of one asset should result in other assets being sold to properly rebalance a portfolio, but many assets like venture capital (“VC”), private equity (“PE”), and others can be quite hard to sell in the short-to-medium term, leaving LPs overallocated to private markets. When the stock market falls dramatically, public market investments fall in value immediately; however, private market investments do not reflect the changing environment right away because they require a manual valuation process that is one to two quarters behind public markets.

In addition, LPs allocating to PE and VC can expect net cash flows to turn negative, a break from the norm of recent years when distributions outpaced contributions, which led to positive net cash flows. During a time of crisis, GPs dislike realizing investments at diminished valuations. Instead, they tend to further invest into existing portfolio companies, or at least hold those companies longer, which leads to reduced distributions. Furthermore, GPs also tend to call down capital more slowly during times of market crisis because deal-making slows substantially. It is forecasted that it will take months, possibly even until the end of the year for transaction volumes to rebound.

The exact repercussions the crisis will have on PE fund performance will remain unknown until we know how deeply the virus will affect global economies. However, we do believe private markets will fare well in the current market environment. Research indicates that while PE exhibits high correlation with public market performance over longer periods of time, in times of volatility it tends to drop less and subsequently outperform. Funds deploying cash through the crisis are in a favorable position to deliver elevated returns given the higher likelihood of finding a bargain in a crisis. Previous crisis funds, such as 2001 or 2009 vintages, posted top-tier metrics; the hope is that this pandemic is consistent with these previous patterns for private equity returns.

Print PDF > Private Equity in Times of Crisis

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

The Stock Market vs. Trump

Though it has so far taken somewhat of a backseat to the COVID-19 pandemic and global protests for racial justice, 2020 is a U.S. presidential election year. As can be seen in the chart, over the last year and the last several months in particular, the S&P 500 has generally moved in line with expectations for Trump’s reelection this November.¹ As the complicated debate over whether the stock market performs better under a Republican or Democratic president continues, the historical numbers show that the market does notably better in an election year when a Republican wins the seat. While there are always many moving pieces, this makes sense, as Republicans are often considered more pro-business and pro-market than Democrats.

Now into June, that correlation has completely reversed. The S&P 500 has continued its recovery, getting back to flat on the year before last Thursday’s correction, while chances of a 2020 Republican victory have hit new lows. Though based on only two weeks of data — and with another almost five months until the election — it is an interesting departure from historical trends. Voters certainly have a lot to grapple with over the next several months and we will continue to follow all developments closely as history is made.

Print PDF > The Stock Market vs. Trump

¹As measured by data from political betting site PredictIt: “Which party will win the 2020 U.S. presidential election?”

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Did Friday’s Jobs Report Overstate the Labor Market Recovery?

On Friday, the U.S. Bureau of Labor Statistics released its employment report for the month of May. To the surprise of many, the economy added 2.5 million jobs during the month, which was a sharp contrast from the projected figure of 8.3 million job losses. Not surprisingly, the unemployment rate dropped from April’s 14.7% figure to 13.3% for May; economists had predicted that May’s unemployment rate would be 19.5%. These unexpected data points have further fueled the equity market rally with the S&P 500 returning 2.6% on Friday when the report was released, and it has continued its upward trajectory into this week as well. Furthermore, Treasury yields have risen based on optimism about economies re-opening and the presumption that the worst is behind us from an economic bottoming perspective. Markets are forward-looking and appear to be pricing in further recovery as 2020 progresses. The stimulus policies and limited re-openings seem to have had an early effect and the data may suggest that the damage was not as deep as expected. However, despite the positive sentiment about the jobs report, there is some concern that a classification anomaly for job losses may have inflated Friday’s numbers.

More specifically, the report had a misclassification issue where employees who were temporarily laid-off were considered employed. If corrected, the unemployment rate should be 3% higher. Additionally, the data collection for the report was through the first week of May and further job losses and lay-offs for the remainder of the month were not addressed.

Compared to the trends from March and April, the reported figures are moving in the right direction, even though this classification issue makes the numbers from Friday appear a bit more optimistic than reality. Ultimately, the unemployment rate is the highest since the Great Recession and recovered payrolls are only about 10% of those that were wiped out during the pandemic. So while the data shows that the market is heading in the right direction, it is too early to make conclusive decisions about the state of recovery until we see a more sustained pattern of job creation and economic growth.

Print PDF > Did Friday’s Jobs Report Overstate the Labor Market Recovery?

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

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